The Second-Slowest Prey

By: Michael Ashton | Fri, Mar 9, 2012
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Finally, we can perhaps put Greece in the rear-view mirror. The result of the exchange "offer" produced around 83-85% commitment (there are several conflicting calculations out there), although much less on the foreign-law bonds which subsequently saw the exchange deadline extended as a result. Some reports say that 85% is a "very high" participation, with at least one report I read saying that it was "higher than even the most-optimistic estimates beforehand."

That's certainly false. Greece was publicly aiming for 95% and threatened the holdouts with every plague conceivable. Ultimately, they had to exercise the retroactively-added Collective Action Clauses, and triggered a Credit Event (therefore bringing to nothing the billions of dollars wasted trying to avoid just such an event), and will still fall a bit short. Troika representatives said a tranche of the second bailout will be released while further discussion continues on the next tranche.

It is important, and sad, to note that when-issued trading of the substitute securities being issued in exchange indicate yields of over 20%. Remember that one of the points here was to restore Greek access to markets - but, despite the fact that they continue to run large deficits (something about the economy contracting at a 7% annual rate will do that), there is no chance that they can raise more money on their own at anything like a sustainable rate. It doesn't help that all future Greek govvies, and the existing exchange debt, are now subordinated debt.

Greece, in short, is "saved" only in this sense: they were being chased by a lion, and they managed to become the second-slowest prey for a little while. The lion is now zeroing in on Portugal, with everyone cheering for Portugal...except for Greece.

It will slowly dawn on investors that this solution, as painful and costly and dramatic as it was, buys only a short period of time for Greece. And there's no way to 'get its house in order.' The right thing to do at this point would be to use the period of relative calm to gracefully leave the Eurozone and devalue. But being the second-slowest prey might provoke undeserved optimism, a vain hope that the lion will be sated soon (or tire of the chase). It would be a terrible mistake to take this as a signal that the worst is over, at least in Greece.

Hopefully, though, Greece will at least move lower in importance for a little while, so we can concentrate on other developments that in the absence of crisis are more-relevant to the dollar-based investor. Developments such as another decent month of Employment growth: in February, the economy generated 227,000 new jobs, a bit better-than-expected with the upward revisions to the prior month. The Unemployment Rate stalled at 8.3% as the number of unemployed actually rose as well (the Civilian Labor Force swelled 476k this month, and this time we can't say it had anything to do with benchmark revisions - the labor force participation rate ticked up to a still-anemic 63.9%). Most of the internals were pretty good, although one indicator I follow is curiously flaccid. The chart below shows the number of respondents to the household survey that are "Not in the labor force but want a job now." That is, they responded that they are not looking for work (ergo, they are not in the labor force, since you need to be employed or looking for work to be considered in the labor force), but would take a job if they thought there was one on offer.

Graph showing people not in labor force who want a job now

This is an interesting series because it's a weird category - if you want a job now, why aren't you looking? These people are not officially "discouraged" workers; that's another series. These are folks who just don't think it's worth the time to look. As you can see, from 2001 through the crisis, there were generally about 4.5mm-5.0mm people in this category, and so there is something like 1.5mm people who conceivably could enter the labor force to soak up jobs. That's roughly 1% on the Unemployment Rate.

The number has been this high before: back in 1994 (as far back as BLS data goes for this series), there were also about 6.5mm in this category, and between 1994 and 2000 the number slowly dwindled. Now look at the chart below (Source: Bloomberg), and you will see that between late 1994 and 2000, the Unemployment Rate's rate of improvement slowed. Had the 1% drag from this category not happened, the slope of the improvement would have been nearly constant.

US Unemployment Rate

Now, I'm actually not claiming that the rate of improvement slowed because of this factor; in 2003-2007 the slope of improvement in the Unemployment Rate was about the same as it was in 1995-2000 so it's more likely that the slope is related to the level - once you get below 6%, you can't expect more than about 0.3%-0.5% per year. And, now that the Boomers are retiring, the employment dynamic is clearly different anyway. But the persistence of a large group of people who "want a job now" but aren't working should dampen out enthusiasm a little bit about the improvement from 10% to 8.3% Unemployment over the last two years. That was the easy 2%. The next 2% is likely to take longer. To get down to the highs of the last recession will probably take three years at least, even though the exit of Boomers from the workforce will help.

Steady improvement in the Unemployment Rate would be a good thing. But what is the implication for Federal Reserve policy of an Unemployment Rate which - even in the absence of another recession, which is certainly not exactly assured - will be over 7% well into 2013? With a bloated balance sheet and core inflation above their target (core PCE right about at the target), if the Fed wants to forestall a bad inflationary outcome it needs to consider unwinding monetary stimulus while conditions are sunny. And yet, we're hearing trial balloons about "sterilized QE3," because the Unemployment Rate remains above 8% and will be above 7% for quite a while.

As I first pointed out in 2010, monetary policy is simple if both the growth and inflation mandates argue for the same policy (in that case, strong provision of liquidity to push inflation higher and, some believe, to improve growth). It gets much harder now. So which is the slowest prey, that tightening policy would bring down first? Growth, financial institution liquidity, or inflation? Unless the answer is "inflation," there are no easy choices from here.



Michael Ashton

Author: Michael Ashton

Michael Ashton, CFA

Michael Ashton

Michael Ashton is Managing Principal at Enduring Investments LLC, a specialty consulting and investment management boutique that offers focused inflation-market expertise. He may be contacted through that site. He is on Twitter at @inflation_guy

Prior to founding Enduring Investments, Mr. Ashton worked as a trader, strategist, and salesman during a 20-year Wall Street career that included tours of duty at Deutsche Bank, Bankers Trust, Barclays Capital, and J.P. Morgan.

Since 2003 he has played an integral role in developing the U.S. inflation derivatives markets and is widely viewed as a premier subject matter expert on inflation products and inflation trading. While at Barclays, he traded the first interbank U.S. CPI swaps. He was primarily responsible for the creation of the CPI Futures contract that the Chicago Mercantile Exchange listed in February 2004 and was the lead market maker for that contract. Mr. Ashton has written extensively about the use of inflation-indexed products for hedging real exposures, including papers and book chapters on "Inflation and Commodities," "The Real-Feel Inflation Rate," "Hedging Post-Retirement Medical Liabilities," and "Liability-Driven Investment For Individuals." He frequently speaks in front of professional and retail audiences, both large and small. He runs the Inflation-Indexed Investing Association.

For many years, Mr. Ashton has written frequent market commentary, sometimes for client distribution and more recently for wider public dissemination. Mr. Ashton received a Bachelor of Arts degree in Economics from Trinity University in 1990 and was awarded his CFA charter in 2001.

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